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CDS Protection on an Issuer’s Own Debt and Sovereign Bonds

Article Quant Q&A · Author: Excalibur
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Summary

The document explains who can sell credit default swap protection on debt. Its central distinction is that CDS protection references debt securities, rather than an issuer’s general assets. A company cannot sell protection on its own debt, but it may sell protection on sovereign debt, including the bonds of the country where it operates.

The discussion highlights wrong-way risk: a company’s financial health may be closely tied to its home sovereign, so both could default under related conditions. A buyer may therefore value protection on that sovereign at a discount, reflecting the risk that the seller could be impaired when the protection is needed. The answer offers a concise conceptual explanation, but no formal pricing method, supporting research, or legal and market-specific detail. It does not address how rules or contract terms might vary across jurisdictions or transactions.

Key ideas

  • CDS protection references debt securities rather than an issuer’s general assets.
  • A company cannot sell protection on its own debt.
  • A company may sell protection on sovereign debt, including that of its home country.
  • Correlation between a seller’s default and the referenced sovereign’s default creates wrong-way risk.
  • Buyers may discount protection when wrong-way risk weakens confidence in the seller.

Tags

Fixed incomeDerivatives pricingRisk management
Full text
# Is it possible to sell protection on own asset with CDS?


# Is it possible to sell protection on own asset with CDS?












Is it possible for a company to sell protection on their own assets or own country bonds by CDS? The company can buy protection on those assets, but how about selling? I suppose it can not sell. Is there any paper, writing about the subject? Thanks.

## Answer by dm63 (score 2)

https://quant.stackexchange.com/a/37058

First, I would emphasize that default protection is bought and sold on debt securities , not on assets. To answer your question, you cannot sell protection on your own debt. You can sell protection on sovereign debt, including the sovereign where your company is based. However, the buyer of this protection understands that there may be a high correlation between the default of the sovereign and the default of your company (the so called wrong way risk mentioned by @noob2), so the price they pay for this protection may be a discount to the full market price.

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.